Sentencing of Corporate Fraud and White Collar Crimes

Good morning Judge
Murphy and Members of the Commission.Thank you for the opportunity
to testify on the proposed amendment regarding corporate fraud and,
more generally, about the nature of white-collar crime
sentencing.

For the record, I
am a Senior legal Research Fellow in the Center for legal and
Judicial Studies at The Heritage Foundation, an independent
research and educational organization. I am also an Adjunct
Professor of Law at George Mason University where I teach Criminal
Procedure and an advanced seminar on White Collar and Corporate
Crime.I am a graduate of the University of Chicago Law School and a
former law clerk to Judge R. Lanier Anderson, III, of the U.S.
Court of Appeals for the Eleventh Circuit.For much of the first 15
years of my career I served as a prosecutor in the Department of
Justice and elsewhere, prosecuting white-collar offenses.During the
two years immediately prior to joining The Heritage Foundation, I
was in private practice representing principally white‑collar
criminal defendants.I have been a Senior Fellow at The Heritage
Foundation since April 2002.

The Commission
considers today, among other issues, the proposed permanent
amendment to the Sentencing Guidelines implementing the directives
of the Sarbanes‑Oxlely Act of 2002, Pub. L. 107-204.To a
large degree the base text of this proposed permanent amendment
mirrors the temporary, emergency amendment made by the Commission
last December, which took effect in January 2003.The Commission
also seeks comment on various possible "Options" that might be
considered as alternatives to the base proposal.

Though it is far
too early to have any empirical data for assessing the effect of
the temporary amendment, it has already generated substantial
commentary.In particular, some commentators, most notably the
Department of Justice, think that the temporary amendment did not
go far enough in implementing Sarbanes-Oxley and suggest that the
provisions of the Guidelines regarding corporate fraud be further
strengthened - they therefore advocate both further enhancements of
the loss table and, in some instances, a higher base offense level
for fraud offenses.

Allow me to take
this opportunity today to discuss with you two issues regarding the
pending proposal:1) The conception of "white-collar" crime and how
that effects proposals to further modify the fraud loss table
and/or the fraud base offense level; and 2) A modification of the
director and officer provisions of the Guidelines to take account
of the burgeoning legal concept of "managerial liability."

White Collar crime, Business Fraud,
and Regulatory Fraud

The proposal before the Commission would (as did the emergency
amendment) add two new levels to the loss table in section 2B1.1 at
the top end, providing for even greater penalties for frauds
involving more than $200 and $400 million respectively.It would
also make permanent various new provisions enhancing penalties when
the fraud in question affects a large number of victims, involves a
director or officers of a publicly traded company, or substantially
endangers the safety and soundness of a financial institution, a
public company, or a large private company.

The Department of Justice has suggested that the Commission's
amendments do not go far enough.Rather, the Department believes the
entire fraud loss table requires adjustment and that, to implement
the dictates of Sarbanes-Oxley, the Commission should enhance
penalties for all frauds, not just those at the top end of
the scale.In the Department's view, these revisions are necessary
to insure that "all but relatively minor fraud crimes will result
in prison time for the wrongdoer."The Commission has asked for
comment on this proposal, on specific suggested new loss tables,
and on a related proposal to increase the base offense level for
certain frauds with enhances statutory maximum penalties.

With all due respect to the Department, I believe that the
alternative it urges, embodied in the options proposed for
consideration by the Commission, misread Congressional intent in
enacting Sarbanes-Oxley.

One can always find snippets of legislative history to support most
any interpretation of a Congressional action.Thus, I would not
suggest to you that my reading of Congressional intent is without
any doubt.Nonetheless, I believe that a full review of the
legislative record and, in particular, an understanding of the
context within which the Sarbanes-Oxley Act arose, provides
substantial guidance as to the type of criminality Congress
intended to address.In my judgment it is fair to say that in
passing Sarbanes-Oxley Congress did not have an intent to
enhance penalties for all garden-variety common law frauds - what
one might characterize as "street frauds" for want of a better
word.Rather, I believe that Congress intended to enhance penalties
for a unique subset of frauds - those we identify colloquially as
"white collar," "business," or "regulatory" frauds.In assessing the
Commission's proposal I therefore believe that the appropriate
place to begin is by attempting to define what a white-collar or
regulatory crime is.

It is possible to identify certain hallmarks of white-collar,
regulatory offenses.The type of offense I have in mind - the one to
which I think Sarbanes-Oxley was particularly directed -- is,
classically, fraud by any other name.At their core, business frauds
are no different in motivation from any common law fraud occurring
on the street.Some of the Enron and Tyco allegations, if they are
proven true, will fit comfortably into this classical conception of
crime.

This sort of white-collar crime has been around for a long
while.Many would argue that, viewed through the prism of today,
some of the "robber barons" of the turn of the century were
white-collar criminals.As A.B. Stickney said to 16 other railroad
presidents in the home of J.P. Morgan in 1890, "I have the utmost
respect for you gentlemen individually, but as railroad presidents,
I wouldn't trust you with my watch out of my sight."

Thus, commentators are right to recognize a fundamental similarity
between business frauds and common law frauds insofar as they share
similar aspects of intent or scienter.But the analogy is
not, in my view, complete.It misses important distinctions
(distinctions implicit in the passage of Sarbanes-Oxley) between
common law frauds and white collar or regulatory frauds.For though
both arise from essentially the same mens rea- they
typically are conducted with the same level of willful intent --
they are accomplished by a far different means or actus
reus-- that is, they have a different methodology.Business
frauds differ in the details of how they are executed, in the
sophistication of those who execute them, and in the difficulty
that prosecutors have in unraveling them.

Thus, the reason these types of frauds are distinguished as
white-collar offenses is because of the means the actors have
chosen for committing their criminal offenses.[Another
distinguishing aspect of the definition might be the socio-economic
status of the perpetrator.I hope that all agree that the
socio-economic distinction is (or should be) of no consequence in
setting the appropriate sentencing level.]Recognizing the
distinction in the method or modus operandi of the crime is
are vital in capturing Congress' apparent intent -- white collar
penalty enhancement should focus on those offenses that are frauds
by new and different means - means that we can characterize,
loosely, as "regulatory" means.

What then are "regulatory means?"That is, concededly a hard
question, not capable of a ready and easy answer.I can, however,
sketch some of the parameters of the answer:

First, the subject matter of the offense often involves frauds that
arise not because of their inherently deceptive nature, but because
the frauds conceal a violation of some underlying substantive
statutory scheme that is, itself, a creature of the modern American
regulatory state.No statute is required to identify the criminal
fraud inherent in the Ponzi schemes that were rampant in the
Depression era. By contrast, the "off the books" partnerships
at the core of the Enron investigation become criminal not because
of something inherently wrongful in that type of corporate
organization - rather, they are wrongful solely because they
contravene an existing statutory and regulatory structure.Without
the regulatory structure the crime might well not exist.

Second, the means of carrying out the fraud is through the
instruments of that same regulatory structure.The structure itself
- its reporting requirements and its substantive provisions - is
enlisted by the criminal in aid of his act.The structure provides
the means of both disseminating his fraud and of concealing it.

I realize that these considerations are by no means easy to apply
in all cases.I equally recognize that not all will agree with my
conception of a white-collar offense.Nonetheless, the foregoing
considerations lead me to conclude that the proposed base amendment
under consideration more closely addresses the core concerns, which
animated Congressional passage of Sarbanes-Oxley.A broad based,
one-size-fits-all increase in the fraud loss tables generally would
enhance punishment for both common-law frauds and those business
frauds that arise from the violations of regulatory norms.Such a
result would be, I believe, a misreading of what Congress has
required.

Rather, the Commission should focus on sentencing provisions that
distinguish between business frauds and street frauds.The
provisions relating to the number of victims and threats to
financial institutions go a long way towards making that
distinction -- common law frauds are less likely to have a large
number of victims and are especially unlikely to threaten the
stability of large banks and corporations.Admittedly, the "fit" is
not perfect - there will be some common law crimes captured by
these offense adjustments and some white-collar frauds that are not
addressed.But these two factors would appear to be a suitable proxy
for the general question - is this a "white collar crime?"

The only alternative I can think of to offer the Commission would
be the far more fact intensive alternative of providing a
sentencing enhancement if the crime "involved use of regulatory or
business expertise" or some such formulation.While such an effort
would be more directly, it is an open question whether there is
substantial gain in coverage of the sentencing provisions that are
worth the significant burden that would be placed on the probation
office and the sentencing court if they were required, in each
case, to examine the methodology by which the crime was committed
and assess whether it arose from an abuse of the regulatory
process.Thus, I think the Commission is wise to focus the inquiry
on factors (such as the number of victims and the failure of a
bank) that are readily ascertainable and provide for ease of
implementation.

The Appropriate Quantum of
Punishment

Let me next address directly the nuts and bolts question that lurks
behind some of the criticism - the question of where to set the
penalty levels for fraud.As my comments reflect, unlike the
Department of Justice, in general, I think the Commission has
identified the right factors to consider in responding to
Sarbanes-Oxley.The current level of punishment for fraud is quite
significant.In substantially raising the penalties to be imposed
for the largest frauds, the Commission has, in my view, responded
respectfully to Congressional direction.

That is not, however, the same thing as saying that the quantum of
punishment now imposed is appropriate.That depends, very much, on
one's antecedent view of the severity and societal significance of
corporate fraud in America.When I testified last year before the
United States Senate, I presented some analysis that bears on the
question, a portion of which I'd like to share with you, now:

I considered the federal criminal sentences imposed in Fiscal Year
2000, the most recent year for I had a complete data
set.Significantly, FY 2000 involved data for sentences imposed
prior to the November 2001 fraud guideline revisions, which
substantially enhanced the penalties for fraud even before the
Sarbanes-Oxley Act was passed.

According to Commission's statistics, in FY 2000 federal courts
entered convictions for 58,636 individuals.I examined data
regarding the length of imprisonment imposed by category of
offense:

crime Type

Mean Sentence

(in months)

Median Sentence

(in months)

Robbery

110.6

77.0

drugs --
Trafficking

75.3

57.0

drugs -
Possession

18.5

6.0

Manslaughter

26.1

18.0

Larceny

15.6

12.0

Fraud

18.0

12.0

Embezzlement

9.9

5.0

bribery

16.2

12.0

Tax Offenses

16.6

12.0

Money
Laundering

46.3

33.0

Environmental/Wildlife

14.5

9.5

Antitrust

12.7

6.5

Food &
Drug

23.1

12.0

The mandatory
nature of certain drug offenses is reflected in the data.The
disparity in some of these sentences might be read to suggest that
white-collar offenses are penalized less stringently, than "street
crime" offenses - a reading that would support enhanced penalties
for fraud if one believed that the two types of crime ought to be
equated.

But there are other aspects of this data that are
significant.Insofar as the data are susceptible to analysis, other
than serious violent, personal offenses (such as robbery) and
offenses relating to drug trafficking (including money laundering)
it is noteworthy, I think, that in FY 2000 most offenses were
treated relatively similarly, with typical sentences falling in a
fairly narrow range of from 1-2 years.Even manslaughter sentences
do not vary appreciably from this seeming norm.One might almost
suspect that we had reached a general consensus on the subject as a
society and identified 1‑2 years as the appropriate just
punishment for most criminal offenses.In short, it appears that the
sentencing guidelines, prior to the November 2001 revisions,
reflected a societal agreement as to the equivalence between
white-collar fraud, tax evasion, and simple drug possession.

Sarbanes-Oxley plainly calls for some revision to this calculus.As
to the appropriate quantum of punishment for true white-collar
fraud, I have no crystal ball, nor any independent moral authority
to advise you -- that is Congress' job as the representative of the
American public.

Clearly, though, we can assess the current state of sentencing:The
November 2001 fraud revisions to the Guidelines (as to whose effect
no data is yet available) have already substantially modified the
rough equivalence I identified in FY 2000 data.With the further
revisions adopted as temporary measures last year, I think that in
some instances the current sentencing structure might fairly be
termed "draconian."One can readily imagine, for example, scenarios
where a corporate chief executive has a cumulative offense level in
excess of the current level-43 maximum and receives a life sentence
- a sentence previously reserved for those convicted of
first-degree murder or treason.

Whether this is appropriate is not an easy question to answer,
particularly for an academic happily ensconced in the ivory tower
of a think tank. I certainly yield to no one in my conviction
that corporate offenders ought to be punished no differently then
blue collar offenders when they deserve it.But it is fair to wonder
whether equating corporate fraud with murder or treason truly
captures the "just desert" component of criminal law.

In addition, while the measure of deterrence is for Congress to
decide, not this body, one may fairly wonder if the new sentences
to be imposed are not somewhat more than is necessary to achieve
the other objective of criminal law -- deterrence.I know of no
evidence or study suggesting that substantial additional deterrence
will be achieved by ever more extended incarceration. Indeed, my own
experience is that it is the fact of incarceration, not the
length of incarceration is the primary deterrent.Put another
way, in the white-collar arena, what deters is the prospect of
being caught not the length of sentence to be imposed.

Thus, I would urge caution on the Commission before it rushes to
raise sentence levels further without any empirical data
establishing its necessity.Especially in the white‑collar
area, where rational economic actors understand some of the risks
attending criminal activity, such increases may not be required to
achieve deterrence ends nor may they be "just."

Some Heretical Thoughts on "Managerial Liability"

Finally, allow me to turn to the proposed amendment to section
2B1.1(b)(13) imposing penalties on directors and officers.In my
view, the Commission needs to modify this provision to account for
the legal concept of managerial liability.

The Commission should begin by recognizing a variant form of
white-collar fraud offense - a type that is quite different than
the one we have been discussing thus far.These frauds involve
prosecutions not for common frauds but for violations of rules and
regulations that are part of a larger statutory structure.

In modern America, as the regulatory state has grown, the number of
such criminal offenses has grown apace.They are predicated on
violations of the regulations of the Health Care Finance
Administration, the Occupational Health and Safety Administration,
the Consumer Products Safety Commission and a host of other Federal
"alphabet agencies."The growth in this form of white-collar
criminal offenses is what Professor John Coffee has called the
"technicalization" of crime.For this category of white-collar
offenses, the criminal law is increasingly being used
interchangeably with civil remedies.

Three doctrinal developments define this second type of
white-collar offense and differentiate it from the classic frauds
that are the focus of the Sarbanes-Oxley legislation. First,
this type of white-collar offenses involves the criminalization of
conduct that, in most instances, is not inherently wrongful in the
same way that fraud and bribery are. Rather, we have seen a growth
in the category of "public welfare offenses" - a category first
created with modest penalties and now increasingly
felonized.Second, and of special significance in weighing moral
culpability, the statutes involve offenses where the mens
rea requirement is substantially diminished, if not
eliminated.For example, we now punish as strict liability offenses
the taking of migratory birds - even if done utterly by
accident.

Third, and as relevant to the proposal I advance here, this type of
white-collar offense increasingly involves criminal prosecutions of
managerial officers for, in effect, vicarious liability.This
doctrine known as "managerial liability" or the "responsible
corporate officer doctrine" involves the imposition of criminal
liability on corporate officers who bear a responsible relationship
to some underlying criminal conduct.Unlike traditional criminal
law, those "responsible corporate officers can be convicted and
imprisoned even though they had no active role in the conduct at
issue.Rather, they may be convicted if they merely had, as one
Court has said, the "authority to exercise control over the
corporation's activities.There is no requirement that the officer
in fact exercise[d] such authority."The use of this doctrine
is especially prevalent in many of the regulatory areas such as
securities law that are the precise focus of the Sarbanes-Oxley
revisions being contemplated by the Commission.

Whatever one may think of the concept of managerial liability as a
basis for criminal sanction, none should dispute that there are
fundamental differences in criminal culpability between corporate
managers who are active participants in criminal activity and those
who stand convicted because of their role as officers or managers
within a company and whose liability is based solely on their
authority to act and their alleged failure to exercise that
authority.Yet, the "Role In The Offense" provisions of the
Sentencing Guidelines, § 3B1.1, do not attempt to distinguish
between these two aspects of a corporate manager's potential
relationship to crimes committed by individuals in an
organization.They are drafted solely with the paradigm of an active
managerial participant in mind.Section 2B1.1(b)(13) of the
emergency amendment adopted by the Commission in response to the
Sarbanes-Oxley bill, only serves to enhance this focus - the
unstated premise of the amendment is that the corporate officers
being punished are those who, in fact, did exercise their
authority to direct the criminal conduct in question.Yet, the
provision, as drafted, has no such limitation.It is quite likely
that the penalty enhancements of subsection (b)(13) will be imposed
on directors and officers without regard to their actual
participation and/or culpability in the underlying criminal
offense.

When these sentencing provisions are applied to responsible
corporate officers whose criminal liability is premised solely upon
their status as corporate officers and their theoretical ability to
have avoided the harm in question, the punishment imposed does not
fit the crime.The current Guideline provisions enhancing a
corporate officer's punishment based upon his status as an officer
thus drain the criminal law of a portion of its moral force.

This is not, of
course, the place for an extended discussion of the concept of
"managerial liability" or the growth of the regulatory
state.Suffice it to say that legal obligations have come
increasingly to be imposed by statute rather than through the
common law.The Supreme Court first endorsed the trend in 1943, in
United States v. Dotterweich, 320 U.S. 277 (1943).There the
Court addressed a provision of the Food and Drug Act making it a
crime to introduce into commerce an adulterated or misbranded drug
(that is, one not suitable for consumption or mislabeled).
Dotterweich was the President of a pharmaceutical company that had
transported certain adulterated drugs in interstate commerce.But it
was equally clear that there was "no evidence . . .of any personal
guilt" on the part of Dotterweich - there was no proof that "he
ever knew of the introduction into commerce of the adulterated
drugs in question, much less that he actively participated in their
introduction."

As currently employed, the managerial liability doctrine allows the
conviction of an officer for because he bore a "responsible
relation to the situation even though he may not have participated
in it personally."This "responsible relation" doctrine, is
difficult to cabin or limit.At its inception the Court said
(United States v. Park, 421 U.S. 658 (1975))it could not
define or "even indicate by way of illustration" the class of
employees who stood in responsible relation to a crime.Rather, it
left such definition to "the good sense of prosecutors, the wise
guidance of trial judges, and the ultimate judgment of juries."

Thus, according to
the Court, corporate managers have

not only a positive
duty to seek out and remedy violations when they occur but also,
and primarily, a duty to implement measures that will insure that
violations will not occur.The requirements of foresight and
vigilance imposed on responsible corporate agents are beyond
question demanding, and perhaps onerous, but they are no more
stringent than the public has a right to expect of those who
voluntarily assume positions of authority in business enterprises
whose services and products affect the health and well-being of the
public that supports them.

In sum those who
voluntarily chose to engage in productive economic conduct place
themselves at risk of criminal sanction for their "felony failure
to supervise."As at least one court has noted, this policy decision
to criminalize conduct without reference to whether or not managers
have personally acted in a culpable manner may have the effect of
dissuading those who work to produce goods and services for society
from continuing to do so:"If we are fortunate, sewer plant workers
. . . will continue to perform their vitally important work despite
our decision.If they knew they risk three years in prison, some
might decide that their pay . . . is not enough to risk prison for
doing their jobs."

An understanding of this history allows one to critique the current
structure of the Sentencing Guidelines as inadequately sensitive to
this doctrine.Even if one grants the utilitarian argument in favor
of criminal sanctions - that enhanced penalties will modify conduct
- it is appropriate to recognize that the utilitarian argument is a
different argument from the normal ground of criminal law.It
flows not from a conception of "just deserts" but from an effort to
calibrate the deterrence value of a criminal sanction.And whatever
one may think of how that calibration calculus should be rendered
it is, it seems clear, indisputable that: a) deterrence is only one
aspect of criminal punishment to be considered; and b) with respect
to corporate officers, there is no reason to believe that
deterrence will operate with different effect on the two classes of
actors - those who are active participants in a crime and those
whose conduct is criminalized because of their failure to act.No
matter what the value of deterrence, punishment should be greater
for those whose acts are deliberate and willful acts in furtherance
of a crime than it is for those whose criminality is premised on a
failure to act.Traditional concepts of justice require nothing
less.

Accordingly, a modification of the Guidelines is in order, perhaps
in the form of an Application Note to section 2B1.1(13) along the
following lines [as an aside, I would also urge, at the appropriate
time, consideration of similar guidance with respect to section
3B1.1]:

To qualify for an
adjustment under this section based upon a defendant's role as an
organizer, leader, manager, supervisor, director or officer, the
defendant's conduct must have involved actual participation in the
crime in question.The defendant must have been a direct participant
in the crime or had direct knowledge of the crime.An adjustment
under this section is not appropriate if the defendant's conviction
resulted solely from conduct involving a failure to act when under
a legal duty to do so or where the defendant's conviction otherwise
resulted solely from his status as a responsible corporate
officer.

In my judgment criminal law in a free society must be carefully
crafted to target wrongful conduct, and not be used simply to
ameliorate adverse consequences attributable to a failure to act.
Criminal sentencing should therefore reflect the distinction
between those who act and those who are vicariously responsible for
the acts of others, and reserve the more severe condemnation and
loss of liberty for those who are direct participants in criminal
conduct.The current director/officer provisions of the proposed
amendment lack that distinction and ought, therefore, to be
revised.

Judge Murphy, thank you for the opportunity to testify before the
Commission.I look forward to answering any questions you might
have.

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